The common stock of Modern Interiors has a beta of 1.61 and a standard deviation of 27.4 percent. The market rate of return is 13.2 percent and the risk-free rate is 4.8 percent. What is the cost of equity for this firm?

Question

Quizplus · Accepted Answer

The correct answer is A because the cost of equity for this firm is 18.32 percent. This can be calculated using the Capital Asset Pricing Model (CAPM), which states that the expected return on a stock is equal to the risk-free rate plus a risk premium. The risk premium is determined by the beta of the stock, which measures the stock's volatility relative to the market. In this case, the beta of Modern Interiors is 1.61, which means that it is 61% more volatile than the market. The market rate of return is 13.2 percent and the risk-free rate is 4.8 percent, so the cost of equity for Modern Interiors is 4.8% + (1.61 * (13.2% - 4.8%)) = 18.32%.

The Common Stock of Modern Interiors Has a Beta of 1.61